Portability election emerges as new locus of estate planning

Despite a permanent tax exemption, clients of all sizes have issues to consider

Though the estate tax exemption has been set at $5.25 million, a new area of estate planning is emerging for clients: portability election.

Congress made the election of portability of a deceased spouse's unused exclusion amount permanent as part of the American Taxpayer Relief Act of 2012. Right now, that amount is $5.25 million per person or $10.5 million for a married couple.

In short, if one spouse dies in 2013 after making taxable transfers of $3 million and has no taxable estate, his leftover $2.25 million in exclusion can pass to his surviving spouse, who will have $7.5 million in exclusions to use for lifetime gifts or for transfers when she dies. The executor must make the portability election in a timely manner after the first spouse dies on the estate tax return.

With the exclusion being set at $5.25 million per person, it's easy for affluent clients whose estates don't quite hit that level to write off creating estate plans or building trusts.

But even those in-between clients benefit from establishing trusts in select scenarios, noted Samuel A. Donaldson, a law professor at Georgia State University. He was a speaker Thursday at the National Association of Estate Planners & Councils' annual conference in Las Vegas.

“The question for the client with a combined $4 million estate is now, do you need a trust? In many situations, an outright transfer is perfectly fine,” Mr. Donaldson said.

“But you can do a trust for old-fashioned nontax reasons — you use a trust where there is an absence of trust,” he added.

Indeed, smaller estates may still need protection from creditors or the client may fear that the surviving spouse will be unwilling or unable to manage the assets — or there may be family members who are spendthrifts. In those cases, a trust — even if the estate is small enough to escape estate taxes — may still be warranted, Mr. Donaldson said.

For married couples who have an estate that's bigger than the $5.25 million amount but smaller than the combined exclusion of $10.5 million, some situations may call for a credit shelter trust.

For example, a 45-year-old couple has an $8 million estate and seeks planning. Flexibility in the trust should come first, as the couple still has a long and uncertain future ahead — namely, nobody knows who will die first, when it will happen and how much the trust assets will appreciate in the future.

Portability might make sense in the future, but the credit shelter trust might also make sense to protect the descendants of the spouse who dies first. Further, without a credit shelter trust, the surviving spouse could remarry and the new spouse may end up in line to receive the entirety of the estate, Mr. Donaldson explained.

A provision in the estate planning document can allow for the option of a credit shelter trust for any amount of the estate that the surviving spouse will disclaim in the future. “You don't have to make the decision until the death of the first spouse,” Mr. Donaldson said.

Finally, for the largest clients, strategies such as the zeroed-out wealth transfer and the transfer of partnership interests to a grantor trust can mitigate the effect of estate and other taxes.

One thing worth considering is whether states will recognize portability elections with respect to state-level estate taxes and how that might affect the estate plan itself.

“To my knowledge, there are maybe one or two states that recognize portability elections with respect to the state estate tax,” Mr. Donaldson said. “Most are saying 'no, we'll take that revenue for free.'”